Corporate Governance and the Audit Process*

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  • *

    Accepted by Dan Simunic. An earlier version of this paper was presented at workshops at the University of Waterloo, University of New South Wales, University of Connecticut, Northeastern University, Lehigh University, Monash University, and Edith Cowan University. We would especially like to acknowledge the comments of Joe Carcello, Wai Fong Chua, James Largay, Gary Monroe, Steve Salterio, Ken Trotman, two anonymous reviewers, and the editor, Dan Simunic.

Abstract

There has been growing recognition in recent years of the importance of corporate governance in ensuring sound financial reporting and deterring fraud. The audit serves as a monitoring device and is thus part of the corporate governance mosaic. The objective of this paper is to examine the impact of various corporate governance factors, such as the board of directors and the audit committee, on the audit process. Importantly, there is little professional guidance on how auditors should consider such factors when formulating an appropriate audit strategy, and there has been only one prior study on this issue (Cohen and Hanno 2000). Because there are no current specific auditing standards that relate to the effect of corporate governance on the audit process, we conducted a semi-structured interview with 36 auditors on current audit practices in considering corporate governance in the audit process. Reflecting on client experiences, auditors indicate a range of views with regard to the elements included in the rubric of “corporate governance”. Most significantly, auditors view management as the primary driver of corporate governance. The inclusion of top management in the “corporate governance mosaic” is inconsistent with agency theory's prescription of the board and other mechanisms serving as a means to independently oversee management's actions to protect stakeholders. Auditors consider corporate governance factors to be especially important in the client acceptance phase and in an international context. Further, despite the attention placed on the audit committee in the academic literature, in the business community, and by regulators in different countries (e.g., Canada, United States, Australia), several respondents indicated that their experiences with their clients suggest that audit committees are typically ineffective and lack sufficient power to be a strong governance mechanism. Implications for research and practice are presented.

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